Unlocking Value and Strengthening Your Financial Position

As the finance function increasingly integrates with the business, finance leaders are facing new responsibility. The role of the CFO is transforming to be more strategic and value focused. As this evolution occurs, leaders must take new approaches to evaluating success, managing risk, and maximizing impact. In doing so, there are six key areas CFOs can focus on to unlock value and strengthen the organization’s financial position. By using advanced analytics and collaboration, CFOs can make databased financial decisions that drive impactful results. 

1. Access capital strategically 

Optimizing your organization’s capital structure requires you to strike the right balance of debt and equity to maximize market value while reducing the weighted average cost of capital (WACC). Devising a strategic approach to accessing capital requires CFOs to evaluate the impact of debt and equity financing:

? Debt: Businesses borrow debt in the form of short and long-term loans that carry interest rates. Debt is cheaper than equity, however, excessive leverage can expose companies to higher interest payments, increased volatility, and a greater chance of bankruptcy; too much debt, therefore, can increase your WACC. The cost of debt fluctuates based on interest rates. Monitoring changes in interest rates may allow you to make strategic decisions to reduce your WACC. As interest rates fall, as does WACC, organizations may consider debt financing for income enhancing investments to maximize firm value.

? Equity: Equity typically refers to shareholder equity, defined as the issuance of shares (or a certain degree of ownership) to finance operations. Shareholders carry more risk when purchasing a company’s stock than when purchasing bonds because owners are legally obligated to fulfill their debts. While companies are expected to compensate shareholders reasonably based on market performance, equity capital doesn’t require repayment. Shareholders are taking a greater risk, and therefore, equity is typically more expensive. For smaller businesses, equity may be funded from the owner's personal savings. Although there may not be a tangible cost to put one's capital into the business, there is a real opportunity cost that must be considered since the owner is forfeiting returns that could have been earned from deploying that same capital on other investments. The optimum cost structure cannot be boiled down to a single ratio – the average cost of debt and equity varies by industry and organizational circumstances. For example, the cost of equity for the advertising industry is 9.4%, while the average cost of debt is 3.6%. In the pharmaceutical industry, the average cost of equity is 9.0%, while the average cost of debt is 6.9%. However, as a general rule of thumb, companies should strive to maintain a debt to equity ratio of 2 or less.

2. Enhance Liquidity 

Cash is the lifeblood of a company; therefore, enhancing cash flow should be a top priority on every CFO’s list. There are a few different ways to boost liquidity.

? Restructuring debt agreements: Modifying loan terms may help you reduce monthly payments. Short-term loans have higher monthly repayments because the total value of the loan is divided over a shorter period. Though longterm loans are typically more expensive over their lifetime, their monthly payments are smaller. Renegotiating or refinancing existing loans to ones with longer terms may increase your cash on hand.

? Divest of unproductive assets: If your business is sitting on idle assets (those that don’t directly contribute to revenue generation) find a way to sell them. You can earn some additional cash and eliminate any expenses that you are realizing for unnecessary, unproductive assets.

? Analyze your short-term overhead expenses: Are you spending money on items that aren’t driving value for the business? Eliminating or reducing futile overhead costs is a quick way to put some money back in your pocket.

? Adjust accounts receivable: Changing payment terms or offering incentive for earlier payments can induce prompt payments from clients, getting you cash faster.

? Adjust accounts payable: Conversely, are you paying your accounts payable before they’re due? Can you extend payment deadlines? Delay payment or negotiate longer terms with vendors when possible to increase your working capital and access to cash

3. Seek cost efficiencies

One of the most common and effective ways to increase liquidity is to manage costs and optimize efficiency.

? Take a strategic approach to cost cutting: To avoid irreparable damage in the long term, start by evaluating opportunities to restructure the business and eliminate activities that do not add value.

? Increase economies of scale: Boosting volume often leads to increased productivity and efficiency, which allows organizations to spread cost over a larger number of goods. As a result, companies may reap cost advantages that positively impact the bottom line.

? Analyze and categorize expenses: Avoidable costs are expenses that can be averted because the organization is not contractually bound or obligated to pay them. They are not fundamental to the business, and therefore, if they are not driving value, can be reduced or eliminated to drive cost efficiency. Prioritize your costs to understand what to keep, reduce, and cut.

? Enhance operational efficiency: Companies can significantly reduce administrative and labor costs (and enhance efficacy) by increasing the efficiency of the workforce and operations through new technology, automation, and process improvement.

4. Pursue sources of growth 

In addition to minimizing costs, CFOs should seek to increase the top line. Unlocking value through new avenues of growth is a strategic decision that the CFO should weigh in on. As defined in Ansoff’s Matrix, there are four key ways for companies to power sustainable growth:

? Market penetration: Sell more of your current products in your existing market to increase market share. This popular growth strategy allows companies to leverage brand equity in an existing space, eliminating some of the challenges of new customer acquisition. Market penetration strategies often include promotions, price reduction, marketing expansion, terms enhancement, or distribution channel development.

? Market expansion: Sell current products in a new market. Market expansion often involves positioning your products and services into new geographies. When successfully executed, expanding into new territories can stretch your company’s reach to untapped markets where your products or services are in high demand. A global footprint can build brand exposure and, over time, develop goodwill.

? Product development: Sell new, updated, or augmented products in an existing market. Just as you would sell to an existing customer base in the market penetration strategy, leverage your reputation and brand awareness in your product-development strategy to drive more rapid results.

? Product line extension: Sell new products in an existing product category by leveraging your existing brand equity. Product development is an effective way to sell more to existing customers and adapt to changing consumer demands.

5. Manage risk 

The greatest peril to businesses is not acknowledging the risks. The strategic CFO effectively identifies ongoing and emerging threats and then avoids, reduces, transfers, or accepts risk. Once risks are recognized and prioritized, CFOs can determine the appropriate course of action:

? Avoid the risk: In many instances, adapting business processes, equipment, or material will help companies avoid risk. For example, one of the biggest threats facing companies is cybersecurity. How can updating a platform or changing how customers input information mitigate the risk of a cyberattack?

? Reduce the risk: In most cases, companies can’t completely eliminate a risk, however, there are still ways to manage risks to reduce the likelihood of the occurrence and magnitude of their consequences. For example, employees operating at a manufacturing plant may be exposed to health and safety risks. These risks are part of their job; however, they can be lessened through effective safety training, documenting procedures and policies, complying with legislation, maintaining equipment, and practicing emergency procedures.

? Transfer the risk: Companies can transfer some or all of certain risks to another party through contracting, insurance, partnerships, or joint ventures.

? Accept the risk: Unfortunately, in some cases, accepting the risk may be the only option. For example, all companies grapple with the threat of market shifts; unfortunately, no CFO can fully protect against a recession. They should, however, analyze various impacts on the business by conducting risk-adjusted financial forecasting that generates a range of possible outcomes and probabilities based on multiple risk variables. Stress-testing different levels of threat will demonstrate the company’s risk tolerance and may indicate areas of fragility.

6. Maximize return on capital 

Maximizing return on capital is achieved through cost efficiencies (as we described earlier) and price premiums. However, to achieve a price premium, the value of your products and services must exceed what the customer is willing to pay. Your company can achieve a price premium by:

? Brand strength: Brand recognition and loyalty allow companies to command a price premium. People are willing to pay more for a select brand than an alternative for various reasons:

• Social equity: people’s innate desire to fit in or flaunt status compels them to pay (sometimes significantly) more to own a certain product. For example, the luxury car markup, the additional amount people pay to own a Mercedes or Ferrari is up to 15% more than that of a Toyota or Subaru.
• Quality: Brand loyalty is built through providing customers with high-performance products and services. Athleisure brand Lululemon has earned a devoted following by offering the market superior workout clothes. Though Lululemon is more expensive than its competitors, surveys and glowing reviews tout the higher quality and justify the inflated price tag.
• Innovation: Customers will also pay more for cutting-edge brands that push the limits to enhance capability, design, usership, and experience. For example, Apple charges an “Apple tax” on its computers and iPhones, however, users buy into the premium brand to get the most groundbreaking tech products on the market.

? Customer experience (CX): In addition to paying for quality, social equity, and innovation, customers are seeking a memorable, exceptional experience - and are willing to pay for it. As our economy transitions from service to experience, companies must differentiate through the CX: the activities, processes, organizational structure, and series of interlocking interactions that form a cohesive customer journey. As customer expectations evolve, companies can capture additional value. In fact, companies that prioritize the customer experience earn 60% higher profits than competitors. Disney, for example, is the king of customer experience. Its cross-channel strategy, complete with movies, toys, and theme parks, integrates for an end-toend unique experience that reigns supreme in the entertainment industry.

The future is ripe for CFOs to make a seismic impact in their organizations. With critical data at their fingertips, analytical skills, and strategic insight, the CFO plays one of the most powerful roles in business. By understanding and pulling the strategic and financial levers available, CFOs can drive significant value creation and capture and serve as the strategic financial leader their business needs. 

About Coltivar

Coltivar is a tech enabled consulting company that offers a wide variety of tools, products, and services that are aimed at delivering successful solutions for your organization.

Coltivar has committed itself to studying, researching, writing, and consulting on business strategy and performance improvement. We hope you learned a few things from the content provided and encourage you to reach out if you want to continue your journey of strategic empowerment.

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